CCO Resource Center: Fair Valuation (SEC Rule 2a-5)

Chief Compliance Officer Committee

Fair Valuation Policies and Procedures; SEC Rule 2a-5

On December 3, 2020, the SEC adopted new Rule 2a-5 under the Investment Company Act to govern the fair valuation responsibilities of funds, their boards, and their advisers. [The SEC also adopted a companion recordkeeping rule, Rule 31a-4.] The requirements of the new rule are briefly summarized below. The SEC’s Release adopting the rule and the Institute’s memo summarizing the new rule are available through the links below. At the request of ICI’s CCO Committee, we asked members to share with us the compliance policies and procedures they adopted to implement Rule 2a-5. The compilation of these policies and procedures, which is organized from the shortest to the longest, can be accessed through the link below. While most members shared one set of compliance policies and procedures with us, a few submitted separate policies for the funds and adviser.

OVERVIEW OF NEW SEC RULE 2A-5

SEC Rule 2a-5 will apply to any portfolio investments of a registered investment company or business development company (BDC) that does not have “readily available market quotations.” In general, the rule requires funds and BDCs to perform various functions to determine fair value in good faith of its investments in according with Section 2(a)(41) of the ICA and Rule 2a-4 including:

  • Periodically assessing and managing material risks associated with fair valuation determinations, including material conflicts of interest;
  • Establishing and applying fair value methodologies;
  • Testing fair valuation methodologies; and
  • Evaluating any pricing services used.

While the new rule does not require funds and BDCs to adopt and implement written fair value policies and procedures, the Adopting Release notes that Rule 38a-1 (the Mutual Fund Compliance Rule) requires the adoption and implementation of policies and procedures reasonably designed to prevent violations of the Federal Securities Laws, which would include Rules 2a-5 and the related recordkeeping requirements in Rule 31a-4.

The new rule permits a fund’s board of directors to designate the fair value determination relating to any or all of the fund’s investments to a “valuation designee.” [The board or its valuation designee are responsible for performing the functions listed above.] The designation of a valuation designee is subject to board oversight and such designee must provide the fund board with the following reports:

  • Quarterly reports related to material changes or developments affecting fair valuation;
  • Annual reports related to an overall assessment of the fair value process; and
  • Other reports that are required under certain circumstances (e.g., matters materially affecting valuation determinations, including significant deficiencies or weaknesses in the design or effectiveness of the policies and procedures or material errors in the NAV calculation). These reports must be provided to the board promptly.

A valuation designee must also specify the titles of the persons responsible for determining the fair value of designated investments (including their functions), and reasonably segregate fair valuation determinations from the portfolio management of the fund.

In adopting the rule, the SEC rescinded ASR 113 and 118. Among other things, these ASRs provided guidance on the role of the fund board in fair valuation determinations as well as guidance on certain accounting and auditing matters. SEC staff letters related to the board’s role in the fair valuation process and other matters covered by the new rule were also withdrawn or rescinded.

The new rules were effective 60 days after publication in the Federal Register, which occurred on January 6, 2021. The compliance date for the new rule was September 8, 2022, which is 18 months following the rule’s effective date.

The documentation provided by ICI that may be accessed by members of the CCO Committee is restricted to the member’s use only and not for distribution or reproduction. Documentation may be used internally at member organizations but may not be shared outside the organization.